ECB warns Balkans over excessive reliance on euro

A worker displays a newly minted commemorative 2.5 euro coin to mark the bicentennial of the battle of Waterloo, at Belgium's Royal Mint in Brussels June 8, 2015. REUTERS/Francois Lenoir

SARAJEVO (Reuters) - Western Balkans nations need to strengthen public trust in their local currencies as an excessive reliance on the euro puts their economies at risk, European Central Bank Executive Board member Benoit Coeure said on Friday.

In a region that has lived through wars, dictatorships, economic crises and political instability over the past several decades, more than half of deposits and loans are denominated in euros, reflecting weakened trust in domestic currencies.

“But a high degree of foreign currency use also has serious drawbacks,” Coeure said in Sarajevo. “Unofficial euroization also impedes monetary policy transmission and may limit the overall room for maneuver of monetary policy.”

The lack of exchange rate flexibility makes inflation targeting difficult while at the same time leaving the bank sector vulnerable to sudden currency shocks, Coeure said.

“Households and firms may suddenly no longer be able to service their foreign currency-denominated debt, creating credit risk for banks,” Coeure said, mentioning non-EU members Serbia, Albania, and Bosnia and Herzegovina.

The euro is also widely used as risk premia are lower, funding is cheaper and locals working in Western Europe tend to send home cash in euros, swelling deposits.

Coeure added that the key to strengthening public trust in a local currency is providing central banks independence and a stability-oriented mandate without conflicting objectives.

“The drawbacks of unofficial euroisation deserve policymakers’ attention,” Coeure added. “The expectation that countries will at some point join the EU, and eventually also the euro area, should not divert attention from such policy efforts.”